Risk Management

Southern Discomfort

Suing Auditors after Bum Deals
Marie LeoneApril 1, 2002

If a recent court case in Georgia serves as precedent elsewhere, it could lower the bar on seeking damages based on what company insiders are expected to know and, as a result, pull more third-party auditors into lawsuits.

In January, the Georgia Court of Appeals reinstated a $44 million verdict against Chicago-based accounting firm BDO Seidman LLP, which was charged with misleading an acquirer by overvaluing a target’s inventory.

Three months after the deal was completed in 1993, a subsequent audit revealed that the acquired company’s inventory was worth $70 million less than reported by BDO.

What’s interesting about the award–which was originally thrown out by the trial judge–is that it applies the negligent misrepresentation doctrine to accountants, which is unusual, says Oscar N. Persons, the plaintiff’s attorney and a litigation partner in the Atlanta office of Alston & Bird LLP. The doctrine is used in many states to sue professionals, notes Persons, but accountants are rarely part of the mix.

The other odd twist emerges from the case specifics, says Elliot Cohen, a partner in the New York office of Jenkens & Gilcrest Parker Chapin LLP, who points out that target company insiders were part of the acquisition group. What’s troubling, says Cohen, is that the accountants were held responsible for facts that the company’s own officers thought were incorrect.”The ruling somewhat dilutes the meaning of when reliance is justifiable,” explains Cohen.

Indeed, BDO argues that the plaintiff, Georgia-based Mindis Acquisition Corp., could not have reasonably relied on the target company’s financial statements, because its own chairman and CEO testified at trial that he knew they were wrong. Persons notes that the insiders never said the audit opinion was “wrong,” but rather that they did not have the expertise to make an inventory determination, and therefore relied on BDO.

Nevertheless, should company insiders be allowed to claim that they rely on third-party audits? Georgia’s second-highest court says yes. But BDO has filed a petition with Georgia’s Supreme Court seeking to overturn the ruling.